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China’s currency weakened by 0.15 per cent against the dollar Tuesday. It was a decline that — on its own — seems unremarkable.

But as the trade war between Washington and Beijing drags on, the value of the yuan, also known as the renminbi, is increasingly at the heart of the global fight over trade, technology and economic dominance between the world’s two largest economies.Lately, even the minuscule moves are starting to add up.

Tuesday’s dip pushed the currency to its weakest level against the dollar since early 2008, according to data from FactSet. Since the Trump administration began to talk of imposing tariffs on Chinese exports in early 2018, the currency is down roughly 10 per cent. The drop has picked up speed in August, with the yuan down about 4 per cent.

Allowing the currency to weaken helps China offset the impact of US tariffs on its products. When the yuan crossed 7 per dollar this month — a symbolic level that Chinese authorities had long kept it from crossing — the move was seen as a deliberate effort by Beijing to blunt the Trump administration’s stated goal of cutting the United States’ trade deficit with China.

But the drop also reflects uncertainty about what China’s economy faces, as the global trading system it depends on is thrown into chaos by the trade war. And there’s evidence that Beijing has been trying to prop the currency up, rather than weaken it drastically.

“The trading relationship of China and the rest of the world is changing,” said Ben Emons, managing director of global macro strategy for Medley Global Advisors. “There’s less demand for Chinese goods and less demand for the Chinese currency.”

By definition, any analysis of the movements of China’s currency is partly a guessing game. Chinese policymakers with authority over the yuan aren’t particularly transparent about their intentions.

But it is also becoming clear that, despite China’s financial firepower and technical expertise in managing its economy, the trade war is fundamentally changing the economic system of globalization that enabled the country’s rise.

Large-Scale Economic Factors Are Also at Play

China does set a daily “fixing” around which the currency can trade, but the falling value also reflects the range of large-scale economic factors that would affect any exchange rate: economic growth, interest rates and trade balances.

In China, many of those economic vital signs have been weakening lately, most likely as a result of the spiraling fight over tariffs. Growth is clearly slowing, and interest rates are widely expected to fall as the government tries to keep the country’s expansion alive.

And then there are the tariffs themselves. Economic theory has long predicted that tariffs will result in a weakening currency, for relatively straightforward reasons: They’re designed to cut the exports of the country on which they’re levied, in this case China’s exports to the United States.

If they work, and there is some evidence that American manufacturers are shifting their orders to Vietnam and other countries, it means less demand for Chinese products, and therefore less demand for the country’s currency.

A Vicious Cycle Can Follow a Falling Currency

The dour outlook for the economy may also be prompting some global investors to pull money out of China.More than $60 billion fled China in May and June, the last months for which data was available from the Institute of International Finance, a banking group that tracks money flows to emerging markets.

A weakening yuan itself can also spur capital outflows from wealthy Chinese seeking to protect their savings from devaluation.

Such outflows can be difficult to control, forming a feedback loop in which downward pressure on a currency causes more selling, as more investors rush to cash out of their Chinese investments. When they do this, they convert their yuan in financial markets, effectively selling the Chinese currency — which weakens it — and buying dollars, yen or euros.
China’s Stockpile of Dollars Is Another Clue

Another clue that the falling currency isn’t entirely Beijing’s doing is that its stockpile of dollars hasn’t been growing very much.

Because China sets a narrow price range for the currency, it has to intervene in markets to keep it within that band. If the yuan gets too weak, the central bank will use some of its dollars to buy the currency.

Conversely, when Chinese authorities are trying to keep the country’s currency cheap, they print it and use it to buy up dollars. The result for the Chinese is both a weaker currency and a large stockpile of US dollars.

And for decades, as the Chinese were keeping their money artificially cheap to give their exporters an advantage, the country’s stockpile of dollars surged.

But in recent years, something changed. With China’s growth now slowing, the currency has been weakening. At the same time, China’s stockpile of dollars has declined, meaning that China is effectively selling dollars and buying yuan in an effort to keep the currency stronger.

That means that, as far as we know, China hasn’t been trying to weaken its currency by intervening in the markets. It’s worth noting that public data on the central bank’s dollar holdings is available only through June, so this view may well change when more information becomes available.

The sharp drops in the yuan this month, however, also suggest that China isn’t going to spend too much of its money trying to fight the market forces trying to drive its currency down in value.